Financing Intermediate Inputs and Misallocation: Evidence from China’s Firm-Level Data

Abstract

This paper studies the misallocation of intermediate inputs in China’s firm-level data, eliminating which would increase the average industry’s gross output by 2.93%. We document evidence of pre-pay and financial frictions on intermediate inputs behind the misallocation. We build these frictions into a standard industry dynamics model along with adjustment costs and financial frictions on capital. Counterfactual experiments show that intermediate input frictions, primarily financial frictions, account for 10.8% of China’s gross output misallocation. Value-added gains from reallocating capital, labor, and intermediate inputs are smaller than those obtained when firms are modeled as value-added producers, both in the model and the data.